Voodoo Economics Of the Silver Screen

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Most policymakers have learned to beware claims that tax cuts will "pay for themselves." Tax cuts do spur the economy and create more taxable activity, but few American taxes are so high that this can fully offset the revenue loss from cutting tax rates. Claims about tax cuts paying for themselves are especially problematic at the state level, as the federal treasury receives most of added revenues spurred by lower tax rates.

Yet one area where these "free lunch" arguments retain bizarre resonance is the realm of film tax credits. State lawmakers understand that cutting income tax rates from 6% to 5% will cost the state revenue, but believe that cutting the tax rate on film productions to negative 25% or 40% can pay for itself with the tax revenue generated from related activities. Somewhere, Art Laffer is blushing.

Yesterday, I attended a hearing of the New Jersey Assembly Commerce and Economic Development Committee. Governor Chris Christie suspended that state's film credit program earlier this year, and the legislature is considering a bill to force him to reinstate it. (Formerly, the state subsidized film and television projects to the tune of 20% of their gross expenses, less certain prohibited line items.)

Industry lobbyists turned out in force to explain why giving money to their clients is essential for the state's economy. A representative from NBC/Universal asserted that the firm moved production of Law & Order: SVU to New York for tax reasons, and might not even have cancelled the medical drama Mercy if New Jersey had maintained its subsidy program. Unlike New Jersey, 45 states currently offer some kind of film production incentive.

Christie suspended the film credit program on the grounds that the state could not afford to cut millions of dollars in checks to filmmakers while it grappled with a $10 billion budget gap. But the committee's chairman, a Democrat, asserted that the governor had achieved a false savings: because film tax credits generate so much economic activity, suspending the program would actually make the state's fiscal deficit larger.

If his assertion were true, the Keynesian multiplier on film production subsidies would have to be greater than 10: that is, every dollar of film subsidies paid out would have to generate more than $10 in added economic activity, enough to generate $1 more in state tax receipts.

For comparison, the Mark Zandi model often used to evaluate stimulus proposals uses multipliers that range between 0.22 and 1.74. Perhaps the stimulus package should have included fewer unemployment checks and more film subsidies.

But alas, film subsidies are not this kind of silver bullet. A new report out Saturday from the Michigan Senate Fiscal Agency looked at that state's film tax credit program -- the country's most generous -- and found that even under the most optimistic assumptions, tax receipts driven by new economic activity barely offset 10% of the cost of awarding film tax credits. It estimates that the $125 million Michigan will spend on film credits in FY10-11 will generate just $13.5 million in new tax receipts, for a net fiscal cost of $111.5 million.

Overall, the report does not provide good news for supporters of film subsidies. The report finds the credits will generate just $78.5 million in private sector activity, well below their fiscal costs. It says job creation from film subsidies is "negligible" -- since inception in 2008 they have raised employment in the state by just 0.016% -- and notes that 47% of credit payments leave the state without generating any economic activity in Michigan.

Yet the economic assumptions in the report are actually overly aggressive, failing to fully account for the economic activities that are crowded out by new, subsidized films. With a more accurate reflection of those costs, the report would likely show that the film credit program shrinks Michigan's economy rather than growing it slightly.

Frederic Bastiat admonished economists to be mindful of "what is seen and what is not seen." A government subsidy produces obvious benefits -- economic activity that would not have occurred without the subsidy. The costs tend to be hidden, as they are other government spending programs that didn't happen, or private economic activity that was lost to higher taxes.

The report does account for some of these hidden costs -- particularly, it addresses the fact that awarding $125 million in film tax rebates means that the state's government must either cut spending or levy other taxes to cover that amount. Because of multiplier effects (and, in the case of a tax increase, incentive effects) this causes an economic loss greater than $125 million -- in the estimation of the author of the Michigan report, $213 million.

This inclusion is an improvement over reports commissioned by some other states, which treat the credit spending as "free" -- and, unsurprisingly, have found film subsidies to be great economic boons. However, the Michigan report still does not ascribe a high enough opportunity cost to film spending.

For one thing, it uses the same multiplier to estimate economic gains from film spending and economic losses from offsetting spending cuts or tax increases. Yet, as the author himself notes, opportunity costs should generally be subjected to a higher multiplier than film spending, as much of the knock-on spending generated by films falls outside Michigan. Making this change would increase the estimated private loss, and therefore reduce the measured economic benefit of the credit program.

More problematically, the Michigan report still assumes that there are no opportunity costs on the private sector side of the ledger: that the privately-financed portion of new film productions consists entirely of resources coming from out of state or that would have otherwise sat idle. This is not necessarily true.

All of this is to say that this report's findings -- that Michigan's film credit program is at least a reduced-price lunch, if not a free lunch -- are still overly optimistic. And that bodes ill for the argument that New Jersey must reinstate its film credit program for the sake of "economic development."

Taking a step back, any industry would be thrilled to face a tax rate of negative 20% on gross expenses, as was the case with New Jersey's suspended credit program. They'd be even more keen on the 35% offered in New York City or the 42% on the table in Michigan. It is no surprise that these programs are highly successful at drawing in film productions, at least as long as they remain the most generous in the neighborhood. If a state offered such generous subsidies for rubber ducky manufacturing instead of filmmaking, it would see a proliferation of bath toy factories instead of soundstages.

Yet, this is not the approach we take to economic development in most industries, because it is unsustainable. Handing out huge subsidies costs a huge amount of money. States can afford to do this in film, because it is a small industry -- even with its aggressive subsidy program, Michigan still gets only 0.1% of GDP from filmmaking. But the flip side of that is that the job and economic impacts of film credit programs are small, and the cost is unjustifiably high on a per-job basis.

We are in a film subsidy bubble, and states that trail Michigan and New York would be unwise to bid high enough to win film productions back. Instead, states should foster economic development by improving their infrastructure, human capital, and tax and regulatory environment. Or if they're going to offer incentives to specific industries, they should at least pick less crowded fields than film.

Meanwhile, their residents should sit back, watch Law & Order: SVU, and be thankful they didn't pay for 35% of it without even getting profit participation. No, those suckers are New York taxpayers like me, who will fork over $2.1 billion over the next five years to subsidize film and TV productions. Essentially, I bought you movie tickets. You're welcome.

Josh Barro is the Walter B. Wriston Fellow at the Manhattan Institute.

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